Emerging Markets: What Changed

(from my colleague Dr. Win Thin)

US Treasury Secretary Mnuchin announced that he invited his China counterparts for another round of high-level trade negotiations.
Czech central bank has signaled another imminent rate hike.
The European Parliament voted to censure Hungary for eroding democratic values.
The US State Department announced that it is working on the second round of sanctions on Russia for November.
Central Bank of Russia delivered its first rate hike since 2014.
Central Bank of Turkey delivered a hawkish surprise, raising all rates by 625 bp.
Former Brazil President Luiz Inacio Lula da Silva officially endorsed his running mate Fernando Haddad as the PT candidate.
Incoming Mexico President Andres Manuel Lopez Obrador (AMLO) pledged to boost Pemex spending.

In the EM equity space as measured by MSCI, Colombia (+4.4%), Russia (+4.0%), and Mexico (+3.1%) have outperformed this week, while Brazil (-4.5%), Egypt (-2.7%), and Hungary (-2.7%) have underperformed. To put this in better context, MSCI EM rose 0.5% this week while MSCI DM rose 1.4%.

In the EM local currency bond space, Turkey (10-year yield -84 bp), Malaysia (-7 bp), and Mexico (-6 bp) have outperformed this week, while the Philippines (10-year yield +88 bp), Brazil (+30 bp), and Hong Kong (+14 bp) have underperformed. To put this in better context, the 10-year UST yield rose 12 bp to 2.99%.

In the EM FX space, TRY (+4.0% vs. USD), RUB (+2.8% vs. USD), and MXN (+2.5% vs. USD) have outperformed this week, while ARS (-7.2% vs. USD), BRL (-3.1% vs. USD), and PHP (-0.4% vs. USD) have underperformed. To put this in better context, MSCI EM FX rose 0.1% this week.

US Treasury Secretary Mnuchin announced that he invited his China counterparts for another round of high-level trade negotiations. However, President Trump undermined the notion of improved relations be saying that “We are under no pressure to make a deal with China, they are under pressure to make a deal with us.” Chinese state media tried to set low expectations while noting that China can survive a prolonged trade war.

Czech central bank has signaled another imminent rate hike. Governor Rusnok said he saw no reason to delay the move, noting that economic data would allow rate hikes to continue as early as this month. This comes after Deputy Governor Hampl made similar comments recently. Next policy meeting is September 26, and a 25 bp hike to 1.5% is likely.

The European Parliament voted to censure Hungary for eroding democratic values. The recommendation to sanction under the so-called Article 7 of the EU treaty now goes to a vote by the member governments. Hungary is likely to dodge any sanctions, including suspending its vote in the EU, because it requires a unanimous vote. Poland has pledged to protect its illiberal neighbor.

The US State Department announced that it is working on the second round of sanctions on Russia for November. This would be a follow-up of the August sanctions. As we wrote then, "These sanctions must be enacted within 60 days, and tougher measures are required after three months if Russia fails to prove that it is no longer using or producing chemical weapons." The EU also just extended its sanctions on Russia for another six months, which target senior Russian officials, lawmakers, and military officers with asset freezes and travel bans.

Central Bank of Russia delivered its first rate hike since 2014. Consensus saw no change, but we had highlighted risks of a hawkish surprise. More hikes are likely in the coming months, but we think the pace will depend in large part on the ruble. Governor Nabiullina said rate cuts could resume by end-2019 or early 2020. Again, much will depend on the ruble.

Central Bank of Turkey delivered a hawkish surprise, raising all rates by 625 bp. This was 300 bp more than expected so color us very surprised, as this is the first time in recent memory that Turkey has delivered a hawkish surprise. Recall that it was forcing banks to borrow at the overnight lending rate of 19.25% since August, not the 1-week repo rate of 17.75%. Today, it hiked that 1-week repo to 24% and said banks could begin borrowing at that rate starting tomorrow. As such, the 625 bp of tightening delivered today is effectively only a 475 bp hike in the cost of funds for commercial banks (24% vs. 19.25%).

Former Brazil President Luiz Inacio Lula da Silva officially endorsed his running mate Fernando Haddad as the PT candidate. Lula will remain imprisoned and unable to run after electoral officials barred him. The endorsement came right before the September 11 deadline for the PT to name a replacement for Lula. According to the country’s “clean slate” law, anyone with a criminal conviction that’s upheld on appeal cannot run for elected office.

Incoming Mexico President Andres Manuel Lopez Obrador (AMLO) pledged to boost Pemex spending. His government plans to allocate MXN75 bln ($3.9 bln) in next year’s budget to oil extraction. Furthermore, the government said it will call for bids for oil drilling contracts as soon as AMLO takes office in December. AMLO is clearly seeking to reverse the decline in Pemex oil output, which has fallen every year since 2004.

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